Deck 10: The Fundamentals of Capital Budgeting

Question 1

Accepting a positive-NPV project decreases shareholder wealth.

Answer 1

False

Question 2

Projects that are classified as contingent could be mandatory or optional projects.

Answer 2

True

Question 3

The payback method is a discounted cash flow technique.

Answer 3

False

Question 4

The cost of capital is the maximum return a project can earn.

Question 5

When two projects are independent, accepting one project implicitly eliminates the other.

Question 6

Projects are classified as independent when their cash flows are unrelated.

Question 7

Accepting a negative-NPV project increases shareholder wealth.

Question 8

When two projects have cash flows that are tied to each other, the projects may be classified as independent.

Question 9

Capital rationing refers to the limiting of capital resources to underperforming divisions.

Question 10

All capital budgeting projects are independent projects.

Question 11

Accepting a positive-NPV project increases shareholder wealth.

Question 12

The NPV method determines how much the present value of cash inflows exceeds the present value of costs.

Question 13

Capital budgeting decisions, once made, are not easy to reverse because of the huge investments involved.

Question 14

The discount rate used to determine the present value of future cash flows is the cost of capital.

Question 15

When two projects are mutually exclusive, accepting one project implicitly eliminates the other.

Question 16

The net present value technique is an approach that is inconsistent with the goal of shareholder wealth maximization.

Question 17

The goal of the capital budgeting decision is to select capital projects that will decrease the value of the firm.

Question 18

Capital budgeting plans are made according to the firm's three- to five-year strategic plan.

Question 19

All contingent projects are mandatory projects.

Question 20

Most of the information required to make capital budgeting decisions are internally generated, beginning with the sales force.

Question 21

When mutually exclusive projects are considered, both NPV and IRR will always produce the same acceptance decision.

Question 22

Two projects are considered to be independent if

A) selecting one does not affect whether the other is accepted or not.
B) their cash flows are unrelated.
C) Both a and b
D) None of the above

Question 23

The decision criterion for the accounting rate of return is consistent with the goal of shareholder wealth maximization.

Question 24

Which of the following is NOT true about capital budgeting?

A) It involves identifying projects that will add to a firm's value.
B) It involves investing large amounts of capital.
C) It allows a firm to reverse the decision of large capital investments at any time.
D) It allows a firm's management to analyze potential business opportunities and decide on which ones to undertake.

Question 25

The cost of capital is

A) the minimum return that a capital project must earn to be accepted.
B) the maximum return a project can earn.
C) the return the firm had earned on a previous project. .
D) None of the above

Question 26

Which of the following is a characteristic of independent projects?

A) The cash flows are related.
B) The cash flows are unrelated.
C) Selecting one would automatically eliminate accepting the other.
D) None of the above

Question 27

A construction firm is evaluating two value-adding projects. The first project deals with building access roads to a new terminal at the local airport. The second project is to build a parking garage on a piece of land that the firm owns adjacent to the airport.
If both projects are positive-NPV projects, then the firm should

A) accept both projects because they are independent projects.
B) select the higher NPV project because they are mutually exclusive.
C) accept both projects because they are contingent projects.
D) Not enough information is given to make a decision.

Question 28

The payback method is consistent with the goal of shareholder wealth maximization.

Question 29

When evaluating two projects that require different investments, the IRR does not recognize the difference in the size of the investments.

Question 30

Contingent projects would imply that

A) the acceptance of one project is dependent on the acceptance of the other.
B) the projects can be either mandatory or optional.
C) Both a and b.
D) None of the above

Question 31

The accounting rate of return is not a true return because it simply averages numbers from a firm's balance sheet and income statement.

Question 32

Unlike the regular payback method, the discounted payback method does not ignore cash flows beyond a firm's threshold period.

Question 33

Capital rationing implies that

A) funding resources exceed funding needs.
B) funding needs exceed funding resources.
C) funding needs equal funding resources.
D) None of the above

Question 34

Capital rationing implies that

A) a firm has constraints to fund all of the available projects.
B) funding needs are equal to funding resources.
C) the available capital will be allocated equally to all available projects.
D) None of the above

Question 35

The IRR and NPV decisions are consistent with each other when a project's cash flows follow a conventional pattern.

Question 36

If the payback period for a project exceeds the firm's threshold period, then the project is accepted.

Question 37

Two projects are considered to be contingent projects if

A) selecting one would automatically eliminate accepting the other.
B) the acceptance of one project is dependent on the acceptance of the other.
C) rejection of one project does not eliminate the selection of the other.
D) None of the above

Question 38

Unconventional cash flow patterns could lead to conflicting NPV and IRR decisions .

Question 39

The discounted payback period calculation calls for the future cash flows to be discounted by a firm's cost of capital.

Question 40

Two projects are considered to be mutually exclusive if

A) the projects perform the same function.
B) selecting one would automatically eliminate accepting the other.
C) Both a and b
D) None of the above

Question 41

Which of the following is true about the Net Present Value method?

A) The NPV does not utilize time value of money concepts.
B) The NPV assumes that all cash flows are reinvested at the firm's discount rate.
C) The NPV allows projects to be ranked by rate of return.
D) The NPV is a rate of return that is acceptable to the firm.

Question 42

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the net present value of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $890,197
B) $1,213,909
C) $905,888
D) $777,713

Question 43

Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the net present value of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $645,366
B) $1,213,909
C) $905,888
D) $777,713

Question 44

Which of the following is a disadvantage of the payback method?

A) It ignores the time value of money.
B) It is inconsistent with the goal of maximizing shareholder wealth.
C) It ignores cash flows beyond the payback period.
D) All of the above.

Question 45

Binder Corp. has invested in new machinery at a cost of $1,450,000. This investment is expected to produce cash flows of $640,000, $715,250, $823,330, and $907,125 over the next four years. What is the payback period for this project? (Round your answer to two decimal places.)

A) 2.12 years
B) 1.88 years
C) 4.00 years
D) 3.00 years.

Question 46

Which one of the following statements is NOT true?

A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project has no impact on shareholder wealth.
C) Accepting a negative-NPV project decreases shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.

Question 47

Which of the following is an advantage of the payback method?

A) The technique is simple for managers to compute and interpret.
B) It is a good measure of liquidity risk.
C) Both a and b
D) None of the above

Question 48

Gao Enterprises plans to build a new plant at a cost of $3,250,000. The plant is expected to generate annual cash flows of $1,225,000 for the next five years. If the firm's required rate of return is 18 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $2,875,000
B) $3,830,785
C) $580,785
D) $2, 225,875

Question 49

Choose the answer below that does not describe the circumstances where IRR conflicts with NPV in the decision to accept a project.

A) If the sign of the project's cash flows changes more than once during the life of a project
B) When two or more projects are mutually exclusive.
C) When two or more projects are independent
D) IRR assumes that all cash flows received during the life of a project are reinvested at the IRR while the NPV method assumes that they are reinvested at the cost of capital rate

Question 50

Which one of the following statements about the discounted payback method is false?

A) The discounted payback method represents the number of years it takes a project to recover its initial investment.
B) The discounted payback method calls for a project to be accepted if the payback period is greater than a target period.
C) The discount payback method is a risk indicator.
D) The expected cash flows from a project are discounted at the cost of capital.

Question 51

Which one of the following statements is NOT true?

A) Accepting a positive-NPV project increases shareholder wealth.
B) Accepting a negative-NPV project decreases shareholder wealth.
C) Accepting a zero NPV project has a negative impact on shareholder wealth.
D) Managers are indifferent about accepting or rejecting a zero NPV project.

Question 52

Cortez Art Gallery is adding to its existing buildings at a cost of $2 million. The gallery expects to bring in additional cash flows of $520,000, $700,000, and $1,000,000 over the next three years. Given a required rate of return of 10 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $1,802,554
B) $197,446
C) -$1,802,554
D) -$197,446

Question 53

Johnson Entertainment Systems is setting up to manufacture a new line of video game consoles. The cost of the manufacturing equipment is $1,750,000. Expected cash flows over the next four years are $725,000, $850,000, $1,200,000, and $1,500,000. Given the company's required rate of return of 15 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $1,169,806
B) $2,919,806
C) $4,669,806
D) $3,122, 607

Question 54

Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. What is the net present value of this project? (Do not round intermediate computations. Round final answer to nearest million dollars.)

A) $10 million
B) $12 million
C) $14 million
D) $16 million

Question 55

Jenkins Corporation is investing in a new piece of equipment at a cost of $6 million. The project is expected to generate annual cash flows of $1,850,000 over the next six years. The firm's cost of capital is 20 percent. What is the project's NPV? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $722,604
B) $351,097
C) $152,194
D) $261,008

Question 56

When computing the NPV of a capital budgeting project, one should NOT

A) estimate the cost of the project.
B) discount the future cash flows over the project's expected life.
C) ignore the salvage value.
D) make a decision based on the project's NPV.

Question 57

Which of the following statements about the payback method is true?

A) The payback method is consistent with the goal of shareholder wealth maximization
B) The payback method represents the number of years it takes a project to recover its initial investment plus a required rate of return.
C) There is no economic rational that links the payback method to shareholder wealth maximization.
D) None of the above statements are true.

Question 58

The Cyclone Golf Resorts is redoing its golf course at a cost of $2,744,320. It expects to generate cash flows of $1,223,445, $2,007,812, and $3,147,890 over the next three years. If the appropriate discount rate for the firm is 13 percent, what is the NPV of this project? (Do not round intermediate computations. Round final answer to nearest dollar.)

A) $7,581,072
B) $2,092,432
C) $4,836,752
D) $3,112,459

Question 59

To accept a capital project when using NPV,

A) the project NPV should be less than zero.
B) the project NPV should be greater than zero.
C) Both a and b
D) None of the above

Question 60

The net present value

A) uses the discounted cash flow valuation technique.
B) will provide a direct measure of how much a firm's value will change because of the capital project.
C) is consistent with the shareholder wealth maximization goal.
D) All of the above

Question 61

Strange Manufacturing Company is purchasing a production facility at a cost of $21 million. The firm expects the project to generate annual cash flows of $7 million over the next five years. Its cost of capital is 18 percent. What is the payback period for this project?

A) 2.8 years
B) 3.0 years
C) 3.2 years
D) 3.4 years

Question 62

Carmen Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. The firm's cost of capital is 12 percent. What is the discounted payback period for this project? If the firm's acceptance period is five years, will this project be accepted? (Do not round intermediate computations. Round your answer to one decimal place.)

A) 5.4 years; no
B) 6.1 years; no
C) 6.1 years; yes
D) 4.2 years; yes

Question 63

In evaluating capital projects, the decisions using the NPV method and the IRR method may disagree if

A) the projects are independent.
B) the cash flows pattern is unconventional.
C) the projects are mutually exclusive.
D) Both b and c are correct.

Question 64

Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The machinery will result in additional annual cash flows of $375,000 over the next five years. The firm's cost of capital is 10 percent. What is the discounted payback period for this project? If its acceptance period is three years, will this project be accepted? (Do not round intermediate computations. Round your answer to one decimal place.)

A) 2.7 years; yes
B) 4.7 years; no
C) 2.3 years; yes
D) 4.3 years; no

Question 65

Modern Federal Bank is setting up a brand-new branch. The cost of the project will be $1.2 million. The branch will create additional cash flows of $235,000, $412,300, $665,000 and $875,000 over the next four years. The firm's cost of capital is 12 percent. What is the internal rate of return on this branch expansion? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 20%
B) 23%
C) 25%
D) 27%

Question 66

You have been asked to analyze a potential project. The project's cost is $180,000. Cash inflows are projected to be: year 1 = $55,000, year 2 = $65,000; year 3 = $75,000; year 4 = $85,500; year 5 = $95,000. What is the investment project's payback? (Round off to the nearest 0.1 years)

A) 4.1 years
B) 1.6 years
C) 3.5 years
D) 2.8 years

Question 67

LaGrange Corp. has forecasted that over the next four years the average annual after-tax income will be $45,731. The average book value of the manufacturing equipment that is used is $167,095. What is the accounting rate of return? (Round your answer to one decimal place.)

A) 33.3%
B) 27.4%
C) 29.8%
D) 22.3%

Question 68

The internal rate of return is

A) the discount rate that makes the NPV greater than zero.
B) the discount rate that makes the NPV equal to zero.
C) the discount rate that makes the NPV less than zero.
D) Both a and c are correct.

Question 69

Quick Sale Real Estate Company is planning to invest in a new development. The cost of the project will be $23 million and is expected to generate cash flows of $14,000,000, $11,750,000, and $6,350,000 over the next three years. The company's cost of capital is 20 percent. What is the internal rate of return on this project? (Do not round intermediate computations. Round final answer to the nearest percent.)

A) 22%
B) 20%
C) 24%
D) 28%

Question 70

Which of the following statements about IRR is false?

A) The IRR is the discount rate that makes the NPV greater than zero.
B) The IRR is a discounted cash flow method.
C) The IRR is an expected rate of return.
D) None of the above

Question 71

Which of the following cash flow patterns is NOT an unconventional cash flow pattern?

A) A positive initial cash flow is followed by negative future cash flows.
B) A cash flow pattern in which there are alternate inflows and outflows.
C) A negative initial cash flow is followed by positive future cash flows.
D) A cash flow stream looks similar to a conventional cash flow stream except for a final negative cash flow.

Question 72

When evaluating capital projects, the decisions using the NPV method and the IRR method will agree if

A) the projects are independent.
B) the cash flow pattern is conventional.
C) the projects are mutually exclusive.
D) Both a and b are correct.

Question 73

Roswell Energy Company is installing new equipment at a cost of $10 million. Expected cash flows from this project over the next five years will be $1,045,000, $2,550,000, $4,125,000, $6,326,750, and $7,000,000. The company's discount rate for such projects is 14 percent. What is the project's discounted payback period? (Do not round intermediate computations. Round your answer to one decimal place.)

A) 4.2 years
B) 4.4 years
C) 4.8 years
D) 5.0 years

Question 74

Turnbull Corp. is in the process of constructing a new plant at a cost of $30 million. It expects the project to generate cash flows of $13,000,000, $23,000,000, and 29,000,000 over the next three years. The cost of capital is 20 percent. What is the payback period for this project? (Round your answer to one decimal place.)

A) 1.7 years
B) 2.2 years
C) 1.2 years
D) 2.7 years

Question 75

Elmer Sporting Goods is getting ready to produce a new line of golf clubs by investing $1.85 million. The investment will result in additional cash flows of $525,000, $812,500, and 1,200,000 over the next three years. What is the payback period for this project? (Round your answer to two decimal places.)

A) 3.55 years
B) 2.43 years
C) 1.57 years
D) More than 3 years

Question 76

Kathleen Dancewear Co. has bought some new machinery at a cost of $1,250,000. The impact of the new machinery will be felt in the additional annual cash flows of $375,000 over the next five years. What is the payback period for this project? If its acceptance period is three years, will this project be accepted? (Round your answer to two decimal places.)

A) 2.67 years; yes
B) 2.67 years; no
C) 3.33 years; yes
D) 3.33 years; no

Question 77

Carmen Electronics bought new machinery for $5 million. This is expected to result in additional cash flows of $1.2 million over the next seven years. What is the payback period for this project? If its acceptance period is five years, will this project be accepted? (Round your answer to two decimal places.)

A) 4.17 years; yes
B) 4.17 years; no
C) 3.83 years; yes
D) 3.83 years; no

Question 78

Creighton, Inc. has invested $2,165,800 on equipment. The firm uses payback period criteria of not accepting any project that takes more than four years to recover costs. The company anticipates cash flows of $424,386, $512,178, $561,755, $764,997, $816,500, and $825,375 over the next six years. What is the payback period, and does this investment meet the firm's payback criteria? (Round your answer to two decimal places.)

A) 4.13 years; no
B) 4.13 years; yes
C) 3.87 years; yes
D) 3.87 years; no

Question 79

Stump Storage Co. is expecting to generate after-tax income of $155,708, $159,312, and $161,112 for each of the next three years. The equipment used will have an average book value of $251,575 over that period. What is the ARR? (Do not round intermediate computations. Round final answer to one decimal place.)

A) 65.7%
B) 69.4%
C) 63.1%
D) 66.8%

Question 80

Jamaica Corp. is adding a new assembly line at a cost of $8.5 million. The firm expects the project to generate cash flows of $2 million, $3 million, $4 million, and $5 million over the next four years. Its cost of capital is 16 percent. What is the payback period for this project? (Round your answer to one decimal place.)

A) 2.7 years
B) 2.9 years
C) 3.1 years
D) 3.4 years